Britain voted yesterday on whether to remain a member of the European Union, and as results were tallied overnight it became clear that the “No” camp had won. Markets do not like surprises and this outcome was very much a surprise as recent polling and odds makers had predicted voters would, by a comfortable margin, elect to remain in Europe.
In response to the surprise vote, markets have dropped sharply, particularly in Europe, reversing the recent run-up in anticipation of a “Yes” vote. For Britain, it seems likely that leaving the EU will result in an economic slowdown and potentially a recession. Further, both Scotland and Northern Ireland voted to remain in the EU, and there is a real possibility over the medium term that they will choose to leave the UK so that they can remain members of the EU.
The larger concern is that the UK vote to leave will weaken the European Union as a whole. Britain’s economy was the third largest in the EU, and more importantly, its exit could lead other countries to consider doing the same. The ensuing uncertainty would have negative economic repercussions, as would the unwinding of the trading block.
There is no doubt that politicians and Central Bankers will move to allay fears in the coming days. A few key things we’ll be watching are:
Whether Britain moves forward with exit – the referendum is not legally binding, and Parliament has the ultimate say regarding moving forward with exit. One of the claims of the “leave” camp was that voting to leave would have little-to-no economic or market impact and that was clearly off-base. In the coming days if the potential economic damage to the U.K. becomes clearer, it is possible Parliament will elect not to move forward with exit, particularly since Prime Minister Cameron has now announced his resignation.
The EU approach to the UK – France, and particularly Germany, have indicated that they would deal swiftly – and presumably harshly – to a request to leave the Union. Such an approach is reminiscent of the way the EU dealt with Greece. At this point, though, given that the UK has one of the larger economies and the EU is facing rising unpopularity among a number of member states, an all stick and no carrot approach is inadvisable. Instead, the EU should focus on the benefits of the EU and re-think the blind adherence to austerity that has been partially responsible for the weaker economic recovery and rising citizen discontent.
The actions of Central Banks – Central Banks will likely take coordinated action to shore up market stability and potentially to bolster economic growth. The Bank of England and ECB have already announced actions to provide additional market liquidity, and here at home, Fed watchers now estimate that the Fed won’t raise rates until autumn at the earliest.
All of this is occurring against a backdrop of a U.S. economy which appears relatively healthy. The Atlanta Fed’s GDPNow which attempts to provide a rough estimate of current economic growth estimates Q2 growth at 2.8%, which is towards the upper end of growth over the last few years. Although the British vote increases economic and market risks, the combination of U.S. economic momentum and room to maneuver available to UK and EU politicians make it possible that the economic impact will be fairly limited.